Imagine that the Crisis was a Shortage of Bread

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The bailout of the banks and the policy of Quantitative Easing constitute the single worst economic decision in history. Let me prove this by way of simple analogy.

Imagine that the problem was not a shortage of loans, but of food, caused by a deadly bug that had contaminated every grain of soil. Only one strain of produce that was immune: wheat. There was one food we could still eat: bread.

Imagine also that the bread baking industry was going through its own crisis because, a month earlier, the UK’s dominant retailing business, Tescopoly, had decided to sell bread at 1p per loaf in order to rid the nation’s high streets of the few remaining shops that were preventing its continued expansion.

The Government decided to bail out the bakers by:

1. Servicing the debts of every UK bakery;
2. Paying senior bakery staff handsomely in return merely for turning up for work;
3. Fixing the price of bread. The market price of a loaf was £2 (pre-Tescopoly). The price was now fixed at 40p. [UK interest rates were cut post-crash to 1% from 5%, an 80% reduction.]

How much bread did the bakers produce after this bailout?

As the disappointing news of continued starvation spread reports emerged of bakers stockpiling wheat yet ordering new Ferraris.

A second emergency policy was announced: falsifying the wheat accounts. The public knew that the exercise was simple false accounting, but they did not object, so desperate were they for any hope of increased bread production.

Virtual computer generated wheat was treated as if it were real. It was kept in a virtual cold store and the policy was given a fancy name – “Quantitative Freezing".

Incredibly this policy boosted morale for a year or so and was presented as working.

The emperor’s true nakedness was exposed as the bodies piled up.

A longer version of this article was posted at the Cobden Centre here.

British Airways – Pension Deficit v Slots

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Amidst considerable brouhaha, the market reacted positively to BA’s long-delayed merger with Spain’s Iberia, on an effective 56%/44% basis. Not surprisingly, opposition to the merger has arisen, both from Virgin, who still recall BA’s role in the grounding of Laker Airways, and from the loquacious Michael O’Leary of Ryanair.

BA itself has many other challenges on its plate, ranging from the sharp plunge into losses, expected strikes and ongoing debate about its planned alliance with American Airlines. However, its worsening pension deficit – at an estimated £3 billion and above its current market value – represent a real impediment to completion of the Iberia deal.

Prudently, Iberia included a get-out clause in its market statement – ‘Iberia will be entitled to terminate the merger agreement if the outcome of the discussions between BA and its pension fund trustees is not, in Iberia’s reasonable opinion, satisfactory because it is materially detrimental to the economic premises of the proposed merger.’

Despite the hours of legal time devoted to drawing up this convoluted sentence, it remains opaque. Clearly, though, Iberia could walk away. Moving to its asset base, BA inherited its key asset – 41% of the slots at Heathrow, which drives its valuation. Without them, its core business class operations at Heathrow simply could not function.

Mindful of the £22.5 billion raised from the sale of 3G spectrum in 2000, could the Government not auction the very valuable slots at Heathrow, both to raise funds and to generate more competition?

Of course, BA would vigorously oppose such a policy even if it were phased in over a deferred period. There are also highly complex legal issues relating to slot ownership both in the UK and in the EU.

But does – and should - BA have effective ownership of over 40% of Heathrow’s slots sine die, unless it chooses to sell them?

Local elections in Denmark

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On Tuesday the Danes had to vote for members of the city councils throughout the country. Just two years into a general election this local election is counted as a good forecast of what is to come. The turnout was the lowest in 35 years with only 65.8% of the voters using their democratic right. The Social Democrats are now the biggest municipal party in Denmark and holds the major offices in the four biggest cities including Copenhagen. Most noticeable is the Socialistic Peoples Party which increased its voter share by 7% and now has 14% percent of the votes. The large government party Venstre (the liberal party) experienced a voter slapping downturn of almost 3% and lost their majority of mayors to the Social Democrats.

However, altogether the Government coalition experienced a smaller increase of votes, signalling the possibility that the government will be re-elected. But the government parties still have to show that they can get the Danish economy out of the present crisis without expanding public expenditures further. The next budget already contains a deficit of about 10%, and according to CEPOS this is built upon excessive current expenditure.

With a deficit this large the Danish government will need to cut the public expenditure and reform the Danish labour market at some point however, in a country where more than 30% of the workforce are employed in the public sector, this is not exactly a vote maximizing strategy.

A balls-up in education

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Ed Balls plans to give parents and pupils a list of legal rights, with guaranteed standards, and the right to challenge schools through an ombudsman, and in the courts, if the provision of this 'bill of rights' is not met.

This shows everything that's wrong in schools - and public services generally. They are centrally planned and uniform, and unless you have lots of money, customers (in this case, parents) cannot escape and go elsewhere. In competitive businesses, providers have to focus on customers and serving their needs. In monopoly state services, there is no need to bother. So as the complaints mount, ministers send out one central directive, then another – Stalin-style. None of it does much good, and the complaints continue. So then they move to give customers 'voice' – saying they are guaranteed this standard, that standard, this right and that right, and can have a say in how things are run.

This has never worked. Most parents, patients, and public service users do not want to sit on a governing board or have to bother with constant public meetings and elections (I sat on a school board for four years, and became an elector for my local hospital, and I must say that both were a complete waste of time). Public service users certainly don't want to be bothered complaining to an ombudsman or spend the nervous energy going to court if their treatment is poor. They just want a decent service. In a competitive sector, like supermarkets or filling stations, they can just take their custom elsewhere. They don't need to sit on the board of Tesco or Asda – they just go elsewhere, and that sends a vital signal to the providers about what customers actually want. Exit is far stronger, and easier, than voice.

It really does give the impression of beleaguered government strategists pushing phantom armies across the map. In a statement that shows the system's complete contempt for customers, school heads have said it will be a 'whingers charter'. Well, we need more people to whinge at bad service. But we also need to give them the power to go somewhere else. That is why a Swedish-style state-money-follows-the- child voucher system, which the Tories are considering, looks so attractive.

Dr Butler's book The Rotten State of Britain is now in paperback.

Aid we give to the Third World is more harmful than helpful

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Despite record levels of foreign aid for health, almost no progress is being made in improving child mortality in the poorest parts of sub-Saharan Africa.

Many countries are going backwards. This is not surprising. The UN and British government – egged on by NGOs and activists – has bet the house on the daft idea that if western governments transfer enough money to governments in poor countries, health systems will magically improve and medicines will get to sick kids. As far as strategies go, this is a turkey.

Once it makes it to the recipient government, what happens to that money is anyone's guess. There is almost no data on how aid money makes its way through recipient health systems.

We do know, however, that much of it is lost to corruption – from ministers skimming off their share of grants, to local health workers charging patients for nominally "free" services. Then the Western consultants and NGOs need to take their cut.

When some aid money does make it to local clinics, World Bank research shows it is most often the educated, urban classes who benefits, rather than the rural poor for whom it is really intended. To cap it all, the influence of Western NGOs on donors has also meant that "fashionable" diseases such as HIV get the lion's share of funding, to the detriment of less high profile problems such as pneumonia, which kill many, many more.

In the short-term, donors could spend taxpayer's money more wisely by bypassing governments altogether, instead putting health services out to competitive tendering amongst the voluntary or private sectors. In the long term, we can't hope to improve child mortality by simply beefing up aid. There is no way western aid agencies can fund a clean water supply, health services and a decent daily meal for every child in Africa. Even if such a thing were logistically possible, such large inflows of hard foreign currency would wreak havoc on fragile local economies.

In the end, the only way to solve child mortality is by fostering economic growth.

The author is Senior Fellow at the International Policy Network. This is taken from the Independent's World Vision blog: The Aid Debate

Welfare without the state

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Earlier this month the Adam Smith Institute hosted a TNG meeting at which Chris Mounsey spoke on the problems and possible solutions to the welfare state in the UK. As part of his speech he highlighted the value of ‘friendly societies’ or co-operatives as one of the possible solutions, collectives that had previously existed in much of Britain and functioned well prior to the National Insurance Act. As he pointed out, amongst the benefits of these organizations are that they are more needs based and are able to prevent many problems such as fraud and lack of accountability in the government run system.

Although the rise of government welfare has had a similar impact on US private welfare as in the UK, the case of the Church of Jesus Christ of Latter-day Saints (the Mormon Church) has survived the onslaught and is insightful in considering how private welfare can function outside of the state. Members of the church fund the program; on the first Sunday of every month everyone skips two meals and donates the saving from those meals. If a member loses income, becomes unemployed, etc. they meet with their local leader and together they determine the needs of that individual or family, and assistance is given accordingly.

Accountability is at the center of the program: if an individual is on Church welfare he must meet with his local leader each week to determine what progress he or she has made and what else might be done to fix the situation – often families are asked to sacrifice items such as cell phones and cable television before financial assistance is rendered. The Mormon Church also has its own employment services that help individuals seek employment through networking and Church run companies and organizations. There are even private markets, referred to as Bishops’ storehouses, in which individuals can purchase food for nearly 90% below market value while they are in the welfare system.

The program that the Mormon Church has developed creates a sense of accountability and helps people improve their circumstances rather than slowly becoming dependent upon the system. Co-operatives are able to do what no government can, by creating true accountability and fostering the importance of self-reliance and accomplishment. Yet religious commonality is not necessary to create the type of ‘friendly society’ the Mormon Church has. Private groups like this could flourish if it wasn’t for one major problem: the government does not allow you to opt-out of the state run system. If the state allowed an opt-out option for those who can confirm enrollment in a private co-operative, things would improve dramatically and private co-operatives would spring up everywhere.

42 years ago today...

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It does not mean that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.

Harold Wilson 'Wilson defends 'pound in your pocket' BBC (1967).

Over at the Cobden Centre

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Imagine that the financial crisis was a shortage of bread.

Not fair to blame the bankers

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Click here to view Eamonn Butler, director of the Adam Smith Institute, defend bankers against accusations of greed in the FT's Money and Morals series. Also, click here to watch a debate between Eamonn and Giles Fraser of St Paul's Cathedral.

Can government be limited?

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Last week I bemoaned the fact that the EU’s Lisbon Treaty fails to set any real limits on the size and scope of EU government. This is a significant failing: surely defining and limiting the proper role of an institution is one of the primary roles of any constitutional document? That said, it is also worth asking whether constitutional limits on government actually work, or whether they are ultimately powerless when faced with a state intent on expansion.

Political theorist Anthony de Jasay would argue that the latter statement is the more accurate one. To use his example, a government accepts constitutional limits to gain the confidence of its subjects in much the same way a lady agrees to “wear a chastity belt to reassure her lord". However, with the key to the belt always within reach, “it can occasion delay, but cannot stop Nature". When government itself has the ability to amend a constitution, that constitution cannot absolutely limit its power. Indeed, outright amendment is rarely even necessary – an expansive ‘interpretation’ of the constitution can often achieve much the same end.

The American example is instructive here: as the Cato Institute’s William Niskanen has pointed out, the US Constitution only authorizes the Federal Government to exercise “18 rather narrowly defined powers". And yet since the 1930s, the powers of that Federal Government have “expanded enormously without a single amendment to the Constitution". Much of this is due to the ‘interstate commerce clause’, which is today interpreted in a way that would horrify the Founding Fathers. The result is a Federal Government that “acts as if it has the authority to define its own powers" and seems to grow faster with every passing year.

On the other hand, it might be that there are some constitutional devices that could succeed where others have failed. The best would probably be those that limited the ability of government’s to tax, spend, or print money. Government spending could be strictly limited to projected revenues, while any tax rises or new taxes could be made subject to affirmation in a referendum. Likewise, the long-term growth in the money supply could be strictly limited by a constitutional rule like the one Milton Friedman suggested.

Another idea is the ‘non-discrimination clause’ advocated by James Buchanan. As John Meadowcroft has put it, this would make “legislation that discriminated on the basis of sex, race, age or religion, or on the basis of occupation, income or wealth" unconstitutional. Such a clause would outlaw the allocation of government privileges, and would only allow a flat tax. It would also require any benefits to be universal. The result, in theory, would be to prevent the exploitation of particular groups via the political process, while also balancing the incentives in the democratic system – people would in future only be able to ‘vote themselves more money’ by also voting themselves a higher rate of tax.

Whether or not these measures would work in practice is difficult to predict in advance. The democratic state tends naturally to grow, and de Jasay may be right that attempts to constitutionally limit its size are doomed to eventual failure. But despite that, I’d say it was still worth trying.